Stocks, Rocky Balboa, and Muhammad Ali

Michael A. Gayed, CFA, winner of the 2014 Dow Award, is chief investment strategist and co-portfolio
manager at
Pension Partners, LLC., an
investment advisor which manages mutual funds and separate accounts according
to its ATAC (Accelerated Time and Capital) strategies focused on inflation
rotation. Prior to this role,
Gayed served as a portfolio manager for a large international investment group,
trading long/short investment ideas in an effort to capture excess returns. From
2004 to 2008, Gayed was a strategist at AmeriCap Advisers LLC, a registered
investment advisory firm that managed equity portfolios for large institutional
clients. In 2007, he launched his own long/short hedge fund,
using various trading strategies focused on taking advantage of stock market
anomalies. Follow him on Twitter @pensionpartners and YouTube
youtube.com/pensionpartners.

I was feeling a bit nostalgic last night and decided to watch Rocky III, which is, in truth, one of my favorite movies of all time (and I am proud to say that). In the film, Rocky Balboa, played by Sylvester Stallone, has an epic fight with Clubber Lang, played by none other than the always great Mr. T.

For those that remember the film, it was premised on the idea that Clubber Lang was too strong a fighter for Rocky Balboa to outbox. How did the Italian Stallion win? Essentially by psyching Clubber Lang out to the point where Mr. T's character got too tired to fight, at which point the tide turned as Rocky won the battle.

The idea, of course, was based on the historic boxing match that took place in 1974 between George Foreman and Muhammad Ali known as the "Rumble in the Jungle." The then-former world champion Foreman was seen as a complete power hitter, as money bet against Ali winning the fight. During the second round, Muhammad Ali used what he called a "rope-a-dope" strategy whereby he leaned against the ropes, covered himself up, and let Foreman swing at him to the point of utter exhaustion. Taunting Foreman, Ali said "is that all you got, George," after which Ali began dominating the match.

The bond market is like George Foreman/Clubber Lang. The stock market is like Muhammad Ali/Rocky Balboa.

Let's think the analogy through. Here we are in what I have been calling a likely "mini-correction" within the broader reflation theme I keep stressing for 2012, with stocks still very near multiyear highs. This despite concern over Spain. This despite Treasury bond yields back at panic levels. This despite earnings which everyone is betting will be weak. This despite no more QE3 from the Fed. This despite a potential "hard landing" in China.

The bears have had the negative narrative on their side for a long time, and yet despite repeated blows, the stock market continues to stand up and take the hits. My colleague Ed Dempsey made a direct point about this on Bloomberg Radio's Taking Stock with Pimm Fox and Courtney Donohoe.

At some point, the bears will get tired, just like Foreman did after massive swings to the head and body of the stock market. At some point, the stock market will start hitting back as the bear trade gets more and more tired, and as more and more people begin to cheer for the underdog.

In essence, this is my Spring Switch idea following the Summer Crash, Fall Melt-Up, and Winter Resolution. While I noted that our ATAC (Accelerated Time And Capital) models used for managing client accounts took us largely risk-off last week, should the decline be shallow, it means the bear argument will simply tire itself out in the face of strong risk-assets, which refuse to go down aggressively.

I have very specifically highlighted two areas. First, on the far right of the chart we can see a sharp period of strength in bonds relative to stocks (mini-correction occurring right now), in a move that one could argue looks similar to late July right before the Summer Crash I began arguing would happen in June was taking place. However, consider context.

Yields on Treasuries were OVER 3% before the spike last year, and yields now are just a shy over 2%. Europe was only JUST starting to become a problem, and now its well known and aggressed through various monetary measures. And while the price ratio of bonds to stocks is back to levels not seen in many, many months, absolute bond yields are nowhere near the same place. This is all happening while stocks remain elevated.

If we assume the very real possibility that bond yields are unlikely to fall dramatically more, it should likely at least rise to the 3% level experienced last year before the Fed's stated inflation target of 2%. How does this happen? With bond prices falling coinciding with money pushing into stocks. I would argue that the ratio should be significantly lower than where it is now, likely at new 3-year ratio lows. This should make some sense. If the market were going to collapse because of the negative narrative we're all so used to hearing, it should have already happened.

At what point will the bears get tired as the stock market uses its own form of a rope-a-dope strategy?

At what point will the stock market say to the bond market "is that all you got?"

This writing is for informational purposes only and doesn't constitute an offer to sell, a solicitation to buy, or a recommendation regarding any securities transaction, or as an offer to provide advisory or other services by Pension Partners, LLC in any jurisdiction in which such offer, solicitation, purchase or sale would be unlawful under the securities laws of such jurisdiction. The information contained in this writing should not be construed as financial or investment advice on any subject matter. Pension Partners, LLC expressly disclaims all liability in respect to actions taken based on any or all of the information on this writing.

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